When a CEO’s self-interest rises above his duty to the company
How one exec hoodwinked the board to get a great pay package — and got fired
What can occur when the board of directors approves the contract for a senior officer to obtain unreasonable compensation?
Steven Berg was an American lawyer and businessman who introduced Repap Enterprises to Third Avenue Funds and became the largest shareholder in the Canadian company.
Berg’s proposed compensation was considered at two board of directors meetings. At the first, the board retained an independent compensation consultant to consider it. Following the second, two directors resigned, one of them the chairman of the compensation committee. The board of directors was reconstituted and approved the new compensation committee’s recommendation supporting Berg’s agreement. It provided generous payments, benefits and perquisites, including a five-year term with renewals, a 25-million-share signing bonus, 75 million shares in stock options, a market capitalization bonus, an eight-year pension credit, and liberal change of control and termination provisions. Berg became Repap’s chairman and senior executive officer.
In approving this agreement, the new board relied on an opinion prepared by Margaret Engel, a Mercer compensation consultant, who, due to time constraints on her opinion, was limited in scope and based it on “high-level observations.”
Engel mistakenly understood that she was providing advice in a non-contentious executive contract. She was not informed that Berg was unknown to the members of the board. Neither she nor the new board knew that his employment contract had met with resistance from the earlier board, that the chair of the compensation committee had resigned and that management was opposed to the agreement and questioned its propriety.
Within a few weeks, the new outside directors resigned and a new board was appointed. Berg was not nominated for re-election. His employment was terminated.
Repap asked the court to set aside Berg’s agreement.
The court’s description of Berg’s evidence is worth noting — in what not to do. As Justice Lax found, “… I do not find Mr. Berg to be a credible witness. His evidence was tainted by self-interest. He was unresponsive to questions. In the face of important documents that were in clear contradiction of his testimony, he made no concessions.”
Berg had received materials from directors and board members indicating their discomfort with his compensation proposal, but did not provide them to the new board.
Ontario Superior Court Justice Lax found that Berg had a fiduciary duty to act honestly, in good faith and in the best interests of his company, as well as to disclose the nature and extent of any personal interest contrary to the company’s. It is not enough, she found, for a senior officer and director to remind their colleagues of the interest in his own contract. They should know not merely that he has an interest, but what it is and how far it goes, and he must see to it that they are informed.
As well, every director or senior officer must place the interests of the corporation above their own. As Justice Lax found, “a reasonably prudent chairman and director acting in the best interests of Repap would have provided a new board with the opportunity to educate itself so as to make informed business judgment. As well, he should have afforded the board adequate time to retain a compensation consultant and instruct the consultant sufficiently to derive an genuinely independent opinion about his own employment contract.”
The court concluded, “Mr. Berg failed utterly in his duties to Repap. His own self-interest prevailed. His conduct was exactly opposite of the conduct the law required of him as a fiduciary – disclosure, honesty, loyalty, candour and a duty to favour Repap’s interest over his own.”
The Ontario Court of Appeal upheld the setting aside of Berg’s contract.
In another decision of the Ontario Superior Court earlier this year, Gary Conn, an officer and director of Goldstone Resources, sought over $2 million based on a management agreement he had signed. It gave him a five-year term with the right to renew for an additional five years and earlier termination only if there was cause. When the shareholders learned of this agreement, they were furious and argued that it was unenforceable because Conn had breached his fiduciary duty to negotiate a fair and reasonable employment contract. Although the employer had a compensation committee, Conn was friends with its head and no one considered the best interests of the company. “In my view,” the court found, “the decision-making process leading up to (the employment contract) was woefully deficient. The evidence supports only one conclusion: The agreement was presented in the form Conn desired and was rubber-stamped by a compensation committee and board of directors friendly to him, rather than mindful of the responsibilities that the law imposes.” The court found that the business judgment rule, which protects officers and directors making decisions in good faith, could not protect Conn since the “honesty, prudence, good faith and reasonable belief in the employer’s best interest was not shown.”
The court set aside the provisions regarding compensation termination as unfair and unreasonable, a finding that resulted from an “abdication of responsibilities, rather than business judgment. … Conn orchestrated a selfish and over-reaching deal.” His actions were driven by “self-interest, unsupported by any reasonable or objective criteria and contrary to the interests of the company he was obliged to protect.”
The law has moved considerably in dealing with fiduciaries. Even if they declare their self interest, they still must act in the best interests of the company. Egregious compensation arrangements can be and are being set aside by the courts.